MACD Generates entry and exit signals for stock traders

If you are a trader, you must have heard this old adage at least once.

But, identifying trends isn’t easy always.

Sometimes, stocks move up or down, without giving any clear signal on the future direction.

Under such conditions how can you be sure about your trade?

The answer lies in how well-versed are you with oscillators.

About oscillators

Oscillators are momentum indicators. In other words, Oscillators measure the strength of the current price trend and also indicate if the underlying trend is picking up or reversing.

Before you read anything further, here’s a caution!

Novice traders/investors make the mistake of using oscillators in isolation, without paying much attention to price charts. This might prove fatal for your trades.

Please keep in mind: Oscillators are always used in conjunction with the price charts.

Unless trends on price charts and oscillators are in agreement with each other, don’t take a trading position.

Before taking a trading position it is important to judge whether or not both, oscillators and price charts have signalled a reversal or continuation.

Advantages of following Oscillators

They indicate trend reversals— the probability of a scrip rising or falling at a fast pace, in the opposite direction with respect to its current trend.

Oscillators help gauge overbought or oversold positions in an index or an individual stock.

An overbought condition indicates that upward momentum of a scrip is weakening and may soon come to an end and there’s a high probability of counter-action or a fall.

An oversold condition indicates that the downward momentum is petering out and an upmove or a corrective rally is on the cards.

Among many oscillators that you can use along with price charts, Stochastic, Relative Strength Index (RSI) and Moving Averages Convergence and Divergence (MACD) are prominent.

Moving Average Convergence and Divergence (MACD)

The MACD indicator combines two moving averages—one is short-term and the other is long-term— to generate a trading signal. Moving averages are calculated based on the closing price data.

MACD measures the convergence and divergence of two moving averages. The absolute difference between them is plotted on the y-axis while the x-axis represents the time period. It’s a lagging but a strong directional indicator.

Two popular combinations of averages are:

12-day and 26-day Exponential Moving Averages (EMA)

12-day and 48-day

One more average, calculated with the help of average MACD data, is superimposed over the MACD graph.

Popular superimposed averages:

9-day EMA (for the combination of 12-day and 26-day EMA). In other words, 9-day EMA of 12-day and 26-day EMA put together.

10-day Simple Moving Average (SMA) (for the combination of 12-day and 48-day EMA).

In the MACD indicator, the zero line is the base line and the MACD line oscillates across the zero line.

If the short-term average is above the long-term average then MACD lays above the zero line and is construed as a positive. This is a bullish indicator.

If the short-term average is below the long-term average then the MACD quotes below the zero line. It is construed as a negative or a bearish indicator.

If both the short-term average and the long-term average are placed at the same level, then it is said to be a neutral trend and the MACD oscillates near zero.

What signals an upmove?

If the MACD line crosses over the zero line, it is safe to assume that the underlying trend is turning bullish and it’s an indication to buy (a case of short-term average crossing long-term average).

After staying above the zero mark, if the MACD line comes near the zero line and again starts moving upward from the zero line, that’s a precursor of a rapid rise in the scrip (a case of short-term moving average taking the support of the long-term average).

The MACD moves above the average line – signal to buy and it is more pronounced if it occurs after a substantial fall.

What signals a bearish trend?

If the MACD lines crosses below the zero line, the trend is assumed to be turning bearish and it’s a signal to sell (a case of short-term average breaking the long-term average).

After staying below the zero line, if MACD bounces back towards the zero line and again starts moving downward, it omens a severe fall (a case of the short-term moving average taking resistance of the long-term average).

The MACD line moves below the average line – a signal to sell and it is more pronounced if it occurs after a substantial rise.

MACD Oscillator

(For illustration purpose only)

MACD indicators can be drawn on daily, weekly and monthly charts.

Please remember this

Chart pattern can also be identified on an MACD graph. Further, we can draw trendlines on it. Violation of trendlines shall be taken into considering while deciding the direction of the future price trend of an index or an individual stock.

(For illustration purpose only)

As demonstrated above, the daily chart of Reliance Industries offered several entry and exit opportunities between April 19, 2018 and December 04, 2018. The first buying opportunity opened up at Rs 954. As you can see, the price was moving up and the MACD indicator line crossed above signal line.

One could have sold the stock at Rs 1,036 when the MACD lined crossed below the signal line. The trend of MACD started showing a sign of fatigue and even the price movement of the stock showed a waning trend.

The stock became a buy again at Rs 1,025 when the MACD line resumed its upmove after touching the zero line and crossed above the signal line. The price chart was also trending up.

If you follow the MACD pattern on the daily charts, you end up making a higher number of trades. MACD oscillator on weekly and monthly charts may give you fewer entry and exit signals but the price action can be more rewarding.

(For illustration purpose only)

(For illustration purpose only)

Now many of you might be interested in knowing if any stock has generated a bullish MACD signal lately, have a look at the chart below:

(For illustration purpose only)

At Rs 3,055, Hero Motocorp recently generated a bullish signal. Do you think you lost this opportunity?

Don’t lose your heart. Have a look at the graph below.

Interesting chart in the making…

Data as on December 12, 2018

At the time of writing this article, RBL Bank showed a bullish engulfing pattern on weekly charts and MACD indicator has also started turning positive. If MACD line in the above graph manages to stay over the average line, on the weekly closing basis (i.e. as per the closing on December 14, 2018), RBL might become a good buy—keep an eye on it.

End note:

MACD is a widely used oscillator and to benefit from it you must meticulously follow the signals in conjunction with price charts. If a signal is generated, you should enter or exit without being emotionally attached to your trading positions—kyon ki bhaiya, sabse bada rupaiya.

Editor’s note

At Ventura Securities, we not only help investors understand theoretical concepts in investing but offer insights on making their practical use to become well-informed investors. To read more such interesting stories, drop us an email at this Id – blogcontent@ventura1.com. We will update you every time we upload such articles.

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